ISSN EUROPEAN ECONOMY. No 2 / 2005 EUROPEAN COMMISSION DIRECTORATE-GENERAL FOR ECONOMIC AND FINANCIAL AFFAIRS

Transcription

1 ISSN No 2 / 2005 EUROPEAN ECONOMY EUROPEAN COMMISSION DIRECTORATE-GENERAL FOR ECONOMIC AND FINANCIAL AFFAIRS Economic forecasts Spring 2005

2 European Economy appears six times a year. It contains important reports and communications from the Commission to the Council and the Parliament on the economic situation and developments ranging from the Broad economic policy guidelines and its implementation report to the Economic forecasts, the EU economic review and the Public finance report. As a complement, Special reports focus on problems concerning economic policy. Subscription terms are shown on the back cover and details on how to obtain the list of sales agents are shown on the inside back cover. Unless otherwise indicated, the texts are published under the responsibility of the Directorate-General for Economic and Financial Affairs of the European Commission, BU1, B-1049 Brussels, to which enquiries other than those related to sales and subscriptions should be addressed.

3 European Commission EUROPEAN ECONOMY Directorate-General for Economic and Financial Affairs 2005 Number 2

4 European Communities, 2005 Printed in Belgium

5 Economic forecasts Spring 2005

6 Abbreviations and symbols used Member States BE CZ DK DE EE EL ES FR IE IT CY LV LT LU HU MT NL AT PL PT SI SK FI SE UK EUR-12 EU-25 EU-15 AC-10 Belgium Czech Republic Denmark Germany Estonia Greece Spain France Ireland Italy Cyprus Latvia Lithuania Luxembourg Hungary Malta The Netherlands Austria Poland Portugal Slovenia Slovakia Finland Sweden United Kingdom European Union Member States having adopted the single currency (BE, DE, EL, ES, FR, IE, IT, LU, NL, AT, PT, FI) European Union, 25 Member States European Union, 15 Member States before 1 May 2004 (EUR-12 plus DK, SE and UK) European Union, 10 Member States that joined the EU on 1 May 2004 (CZ, EE, CY, LV, LT, HU, MT, PL, SI, SK) Currencies EUR ECU DKK GBP SEK CAD CHF JPY SUR USD euro European currency unit Danish krone Pound sterling Swedish krona Canadian dollar Swiss franc Japanese yen Russian rouble US dollar iv

7 Other abbreviations SCPs PEPs NMS SGP Stability and convergence programmes Pre-accession economic programmes New Member States Stability and Growth Pact v

8

9 Contents Overview 1 Chapter 1: The world economy 9 1. Global growth and trade to remain robust Outlook for major economies and selected regions 14 Chapter 2: The economies of the euro area and the EU Growth entered a soft patch in the second half of Financial conditions for firms and households still growth-supportive A return of confidence is key to the growth outlook Modest employment growth Inflation below 2% in 2005 and Broadly unchanged budgetary situation 36 Chapter 3: Member States Belgium: Slowing down after a strong Czech Republic: Strong export growth fuelled by FDI Denmark: Consumer spending booms, net exports burden GDP growth Germany: Growth to continue despite recent setback Estonia: Growth gains momentum while imbalances are starting to diminish Greece: Olympics' bonus tapers off Spain: Widening external imbalances France: Growth remains robust, fuelled by domestic demand Ireland: Adjusting to sustainable growth levels Italy: Recovery carries on at measured pace Cyprus: Strengthening growth with fiscal consolidation well on track Latvia: Vigorous growth and wide current account deficit Lithuania: Robust growth, albeit slowing down Luxembourg: Still growing faster than its neighbours Hungary: More balanced growth, further fiscal consolidation needed Malta: Public finance consolidation reaffirmed Netherlands: Cloudy weather, silver linings Austria: Moderate recovery to continue Poland: Still vigorous growth amidst persistent fiscal uncertainties Portugal: Gradual recovery and persistent budgetary imbalances Slovenia: Strong growth fuelled by exports Slovakia: Domestic demand drives growth Finland: Despite some easing, activity to remain robust Sweden: Domestic demand takes the lead United Kingdom: Wind in the sails 93 vii

10 Chapter 4: Candidate Countries Bulgaria: Continuing high growth with some deceleration in Croatia: Good export performance will drive moderate growth acceleration Romania: The fast ride goes on - buoyant demand and widening trade deficit Turkey: Strong consumer and business confidence boost economic activity 104 Chapter 5: Other non-eu Countries United States of America: Resilient growth set to be supported by external demand Japan: Moderate rebound following the technical recession last year 110 Statistical Annex 113 Tables 0.1 Main features of the Spring 2005 forecast - EU Main features of the Spring 2005 forecast - euro area International environment Quarter-on-quarter GDP growth in the euro area Financing of euro-area non-financial private sector Composition of growth - EU Sectoral employment growth in the euro area Labour market outlook - EU Inflation outlook - euro area and EU General government budgetary position - EU Main features of country forecast - BELGIUM Main features of country forecast - CZECH REPUBLIC Main features of country forecast - DENMARK Main features of country forecast - GERMANY Main features of country forecast - ESTONIA Main features of country forecast - GREECE Main features of country forecast - SPAIN Main features of country forecast - FRANCE Main features of country forecast - IRELAND Main features of country forecast - ITALY Main features of country forecast - CYPRUS Main features of country forecast - LATVIA Main features of country forecast - LITHUANIA Main features of country forecast - LUXEMBOURG Main features of country forecast - HUNGARY Main features of country forecast - MALTA Main features of country forecast - NETHERLANDS Main features of country forecast - AUSTRIA Main features of country forecast - POLAND Main features of country forecast - PORTUGAL Main features of country forecast - SLOVENIA 86 viii

11 3.22 Main features of country forecast - SLOVAKIA Main features of country forecast - FINLAND Main features of country forecast - SWEDEN Main features of country forecast - UNITED KINGDOM Main features of country forecast - BULGARIA Main features of country forecast - CROATIA Main features of country forecast - ROMANIA Main features of country forecast - TURKEY Main features of country forecast - UNITED STATES Main features of country forecast - JAPAN 111 Box Graphs 2.1 Some specificities behind the forecasts The global cycle Growth projections for major economies and selected regions Oil price (Brent crude, $ and per bl.) Interest rates (one-week moving average) Major stock market indices (one-month moving average) Exchange rate developments Exports of goods and real effective exchange rate, euro area Private consumption and consumer confidence, euro area Loans to households, euro area Household saving rates, euro area and Member States Investment in the euro area Business confidence, euro area GDP quarter-on-quarter growth in 2004, euro area and selected countries Bank lending rates to euro-area non-financial corporations Corporate bond spreads over government bonds (monthly averages), euro area Loans and deposits of euro-area non-financial companies with euro-area banks Bank lending rates to euro area households Household debt-to-gdp ratios in the recently-acceded Member States of the EU and the euro area Bank loans to the non-financial private sector Growth contributions, euro area Investment in equipment and real unit labour costs, euro area Distribution of quarterly GDP growth (y-o-y) across the euro area Employment growth and unemployment rate in the euro area Headline and underlying inflation in the euro area Energy, tobacco and health-care inflation in the euro area Headline inflation and inflation expectations in the euro area Belgium - Household savings rate and public debt ratio Czech Republic - Current account and trade balance Denmark - GDP growth and contributions to change in growth Germany - Ifo and consumer confidence Germany - Domestic demand is finally starting to grow again Estonia - Labour market 49 ix

12 x 3.7 Greece - Net lending & consolidated gross debt Spain - Contributions to GDP growth Spain - Household income, savings and expenditure France - GDP and investment France - Household savings rate Ireland - Contributions to GDP growth Italy - Gross value added of the manufacturing sector (constant prices) Italy - Government gross debt and cyclically-adjusted primary balance (CAPB) Cyprus - Government deficit and current account deficit (CA) Latvia - Prices and wages Lithuania - GDP growth and its contributors Luxembourg - Real GDP and employment growth differentials with euro-area average Hungary - HICP Malta - General government finances The Netherlands - GDP growth vs CPI percentage change Austria - Contributions to GDP growth Poland - Prices and wages Poland - General government finances Portugal - Costs and competitiveness Slovenia - Price and wage developments Slovakia - GDP growth and its contributors Finland - Contributions to GDP growth Sweden - GDP growth compared to the euro area United Kingdom - GDP growth in the United Kingdom and the euro area United Kingdom - Unemployment in the United Kingdom and the euro area Bulgaria - Current account balance and net FDI Croatia - Contributions to GDP growth Romania - GDP growth and components Turkey - GDP growth United States - Net exports and their contribution to GDP growth Japan - Quarterly year-on-year growth rates: new vs old method 110

13 Overview Modest recovery to continue in the euro area and the EU Economic activity in the euro area and the EU decelerated in the second half of last year. Nevertheless, supported by the continued buoyancy of global growth and trade, the pace of growth averaged 2% in the euro area and 2.4% in the EU for the year as a whole. As a result of the unexpected deceleration experienced in the second half of last year, due in part to the oil price hike and the strength of the euro, the carryover into this year is lower than projected six months ago. But growth is projected to return to potential during the course of this year - reaching 1.6% in the euro area and 2% in the EU - before accelerating to 2.1% and 2.3%, respectively, in The main factors behind the outlook include accommodative macroeconomic policies, low inflation, supportive financial conditions, widening profit margins, progress in structural reforms, and a supportive global environment. The consolidation of the recovery over the forecast horizon is driven by an acceleration of domestic demand. The pace of investment expenditure, in particular, is expected to pick up and this is accompanied by a more gradual recovery of private consumption. The labour market responds to stronger economic activity. This is supported by wage moderation and the restoration of confidence among consumers and entrepreneurs following the completion of structural reforms. Accordingly, employment growth in the euro area is expected to accelerate from 0.6% in 2004 to 0.7% in 2005 and 0.9% in For the EU as a whole, the profile is similar, although the rise in employment is projected to be slightly lower in Global trade set to remain vibrant, as world economic activity moderates World trade growth is estimated to have peaked at over 10% in With indications of a slowdown in momentum in the second half of last year, the near-term outlook is for a moderation to around 8% this year and somewhat lower in 2006, as the global growth cycle matures. Current estimates suggest that the pace of world GDP growth climbed to a vigorous 5% last year, the fastest pace since the seventies. Economic activity is projected to ease to a still-robust 4.2% this year and marginally lower in The surge in growth has been driven by a number of factors, including supportive macroeconomic policies, historically low real interest rates, housing-market-induced wealth effects, and particularly strong growth in certain emerging economies, such as China, India and, to a lesser extent, Brazil. The regional distribution of global growth continued to widen last year, with stronger contributions coming from the EU, the candidate countries, Latin America, the Middle East and Africa, while the US and some Asian emerging economies improved their already-strong performance. In the US, helped by monetary and fiscal policy stimuli and solid underlying productivity growth, economic activity realised a growth rate of 4.4% in Nonetheless, in view of the high current account deficit and the large general government deficit, this pace of economic expansion is viewed as unsustainable, and accordingly the growth rate is expected to fall to 3.6% this year and to around trend at 3% in

14 Economic Forecasts, Spring 2005 After sliding into technical recession in the middle of last year, the Japanese economy recorded a marginally positive growth rate in the final quarter. However, the weakness is expected to be short-lived as a rebound in domestic demand, especially investment, is set to yield a modest pace of 1.1% this year, before momentum is restored once again next year. Deflation is still present in the economy but is projected to diminish over the forecast horizon. The general government deficit is projected to edge lower to around 6% of GDP in The economic outlook for Asia (excluding Japan) remains bright, with growth in the vicinity of 7% this year and next. Over the forecast horizon, the pace of China s growth is expected to moderate somewhat to around 8.4%, while India s growth rate continues its upward trend. Among the other emerging regions, economic activity in Latin America is set to diminish but remain robust in , while growth should accelerate in Africa. In the candidate countries, the strong performance of last year is expected to be followed by lower, but still robust, growth of around 5% in 2005 and Rising oil prices and historically low bond yields The strong growth dynamic at the global level has sustained the demand for primary commodities. In view of the surge in oil prices to record highs in the first quarter of this year, the assumed profile for oil prices has been revised upwards compared to the autumn forecasts. From an average of USD 47 per barrel (Brent crude) in the first quarter of this year, the price of oil is assumed to rise to USD 52.5 in the second and third quarters before declining gradually to USD 46.5 per barrel at the end of next year. This implies an average of USD 50.9 per barrel for this year and USD 48 per barrel next year. After a rise of 32% last year, this profile implies a further increase of 34% this year, followed by a decline of almost 6% in Although the oil price hike is lower in real terms than during previous shocks and most industrialised oil-importing economies have reduced their dependence on oil, last year s sharp rise dented world growth. The persistence of higher oil prices and their increased volatility have adverse implications for the growth outlook over the forecast horizon. The major stock market indices either remained unchanged or edged upwards during the course of last year. The recent easing of prices has not altered these broad trends. Actual and implied market volatility across most asset classes is historically low. After rising modestly in the first half of last year, long-term government bond yields diminished once again in the second half as fears of an acceleration of inflation and the likelihood of a tightening of monetary policy in some countries receded. Such yields are low by historical standards in both nominal and real terms. Emerging market and corporate bond spreads continued to narrow. Overall, these financial market trends are consistent with a benign view of the prospects for world economic activity. 2

15 Overview The easing of growth in the euro area and the EU towards the end of last year heralded After gathering momentum in the first half of last year, the growth performance in both the euro area and the EU was less inspiring in the second half of the year. In assessing the quarterly data outturn, it is worth noting that the working-day adjustment had a negative impact on the data for the fourth quarter, which may be exaggerated. In Germany, for example, when measured by the non-working-day-adjusted GDP data, the economy grew by 0.4% q-o-q in the fourth quarter of 2004, while the adjusted figure was -0.2%. In any case, for the year as a whole, growth is estimated to have reached potential for the first time in four years, at 2% in the euro area and 2.4% in the EU. During the course of last year, the main driver of growth in the euro area shifted from the external sector in the first half of the year to internal demand in the second half. The strong growth in imports of goods and services, which emerged in the second quarter and was maintained in the third quarter, diminished in the last quarter. This failed to be matched by a parallel performance of exports in the second half of the year, leading to a negative contribution to growth from the external sector in the third and fourth quarters. On the domestic side, the change in gross fixed capital formation moved into positive territory in the second quarter and sustained a solid pace of growth throughout the rest of the year. The surprisingly healthy growth of private consumption in the first quarter proved to be transitory as the subsequent two quarters revealed no impulse to growth from this source. However, the fourth quarter data showed an encouraging pick-up in consumer expenditure. Overall, the momentum achieved in the first half of the year could not be sustained since the stimulus from internal demand in the second half of the year was not strong enough to compensate for the negative impact from the external sector. The outcome for the EU reveals a similar picture in terms of the composition of growth, although the relative contribution of domestic Table 0.1 Main features of the Spring 2005 forecast - EU25 (Real annual percentage change Spring 2005 Difference vs unless otherwise stated) forecast ¹ Autumn 2004 (a) GDP Consumption Total investment Employment Unemployment rate (b) Inflation (c) Government balance (% GDP) (d) Government debt (% GDP) Current account balance (% GDP) ¹ The Commission services' Spring 2005 Forecasts are based on available data up to March 16, (a) A "+" ("-") sign means a higher (lower) positive figure or a lower (higher) negative one compared to Autumn (b) Percentage of the labour force. (c) Harmonised index of consumer prices, nominal change. (d) Including proceeds relative to UMTS licences. 3

16 Economic Forecasts, Spring 2005 demand was stronger than that of external demand on average during the year. As in the euro area, the pace of the rebound in the second half of last year did not live up to expectations in the autumn forecast. Nevertheless, the outcome for the year as whole was only marginally less than envisaged, at 2.4% rather than 2.5%. lower-thanexpected average growth this year, while momentum builds up during the course of the year Following the positive readings at the turn of the year, survey indicators have been sending out mixed signals once again during the first quarter of this year concerning the prospects for the strength and sustainability of the recovery. The Commission s overall economic sentiment indicator for the euro area, which was broadly flat in the second half of last year, dropped below its long-term average in February of this year. After an encouraging rise in January, the composite Purchasing Managers Index (PMI) stalled in February. In general, although the trends are similar, the confidence indicators for the EU tend to exceed those for the euro area. Last year s downwards trend in euro-area business confidence was interrupted by positive readings from a number of leading indicators, including the PMI for manufacturing, the IFO and the NBB in January. However, somewhat weaker survey data for February have cast a shadow over the outlook and the recent surge in oil prices appears to have taken a toll on business confidence. In the services sector, confidence remains lethargic. Although there was some evidence of a change for the better at the turn of the year, the flat trends in the Commission s confidence indicator and the PMI for services for the euro area have been maintained so far in the first quarter of this year. Nevertheless, the levels of the PMI for both manufacturing and services remain consistent with a continuation of economic growth. Consumer confidence, which had been on a gradual rising path since the turnaround in 2003 appears to have stabilised since the third quarter of last Table 0.2 Main features of the Spring 2005 forecast - euro area (Real annual percentage change Spring 2005 Difference vs unless otherwise stated) forecast ¹ Autumn 2004 (a) GDP Consumption Total investment Employment Unemployment rate (b) Inflation (c) Government balance (% GDP) (d) Government debt (% GDP) Current account balance (% GDP) ¹ The Commission services' Spring 2005 Forecasts are based on available data up to March 16, (a) A "+" ("-") sign means a higher (lower) positive figure or a lower (higher) negative one compared to Autumn (b) Percentage of the labour force. (c) Harmonised index of consumer prices, nominal change. (d) Including proceeds relative to UMTS licences. 4

17 Overview year. However, country-specific indicators suggest that there are considerable differences across Member States in the level of consumer confidence. The anticipated recovery in household and business spending in the coming months stems in part from the particularly low real interest rates, both short-term and long-term. The latter have contributed to a relaxation of the balance-sheet constraints of households and businesses through a reduction in debt servicing costs. Corporate profit margins have also widened. The real disposable income of households should be sustained by the projected rise in employment and real wages. The completion of structural reforms in some Member States, the decline in inflation and the effect on wealth of buoyant housing markets in several countries should also provide a positive impetus to consumption. Slow recovery in the labour market The tempered labour market response in the prolonged downturn has been followed by a slow response in the upturn. The rise in the unemployment rate was quite subdued in comparison to previous cycles. The euro-area unemployment rate peaked at 9% in the first quarter of last year, after increasing by one percentage point during the slowdown in the current cycle. This contrasts with a rise of over three percentage points to above 10% in the trough of the early nineties. On the employment side, the picture is also more encouraging insofar as job losses are concerned. No jobs were lost in net terms in the recent downturn, while more than 2.5 million jobs disappeared in the recession. In line with the usual lagged response of the labour market, around one million jobs are expected to be created this year in the euro area and 1.3 million in the EU. These figures should improve further in 2006 as growth regains momentum. The unemployment rate is expected to remain stable at 9% in the euro area and 8.8% in the EU this year, before diminishing in Inflation is projected to remain below 2% in the euro area over the forecast horizon Boosted by such factors as energy price hikes as well as the temporary impact of rises in indirect taxes and administered prices, headline inflation in the euro area remained sticky last year. From an average rate of 2.1% in 2003 and 2004, headline inflation is expected to fall to 1.9% this year, as a result of weak domestic price pressures. A further fall to 1.5% is foreseen for next year. For the EU as a whole, the projected profile over the forecast horizon is flatter. After an initial fall from 2.1% in 2004 to 1.9% this year, a further decline to 1.7% is projected for next year. The falling inflation rates anticipated for the recently-acceded Member States means that inflation dispersion is falling in the EU, although it still remains higher than in the euro area this year. Broadly unchanged aggregate budgetary situation Against the background of a slightly widening negative output gap, the general government deficit for the euro area is expected to post a marginal improvement this year to 2.6% of GDP from 2.7% in This reflects a slightly restrictive fiscal policy stance. For the EU25, the deficit is 5

18 Economic Forecasts, Spring 2005 projected to remain unchanged at 2.6% of GDP this year. On a no-policy change basis, this broad trend should be maintained for both the euro area and the EU in The four countries in the euro area that are in excessive deficit, namely Germany, Greece, France and the Netherlands, are expected to narrow their deficits significantly in However, only in the Netherlands would the deficit be reduced to below the 3% of GDP reference value, while the deficit for France is forecast to be at the reference value. In 2006, on a no-policy change assumption, the deficit is expected to be below 3% of GDP also in Germany, while it is projected to rebound in France and to continue to exceed the reference value in Greece. For Italy and Portugal, where the 2004 deficit was at or just below 3% of GDP, a sharp widening to well above the reference value is forecast in both 2005 and 2006, reflecting a diminished recourse to one-off measures. The projected increase in the Austrian deficit to around 2% of GDP in 2005 reflects the implementation of tax cuts. The remaining euro-area Member States (Belgium, Spain, Ireland, Luxembourg and Finland) are expected to remain broadly in a balanced or surplus position. Outside the euro area, fiscal consolidation in the six recently-acceded Member States that were found to be in excessive deficit last year is proceeding at an uneven pace. Cyprus and Malta are set to reduce the deficit by more than 2 percentage points of GDP between 2004 and 2006 to below the 3% of GDP reference value from 2005 in Cyprus and from 2006 in Malta, both in line with the governments plans. In the other Member States - the Czech Republic, Hungary, Poland and Slovakia - the deficit is still projected to stand at some 4% of GDP in Deficits of around 2% of GDP are forecast for in Latvia, Lithuania and Slovenia. The United Kingdom, which recorded a deficit in excess of 3% of GDP in both 2003 and 2004, is projected to gradually reduce its deficit to 2.7% of GDP in Finally, Denmark, Estonia and Sweden are expected to maintain a surplus over the forecast period, albeit a diminishing one. The general government gross debt ratio is projected to rise by about half a percentage point in 2005 in both the euro area and the EU25, to almost 72% and just over 64% of GDP, respectively. Debt developments are quite diverse among the high-debt countries. With debt ratios well above 100% of GDP, Greece and Italy are the most indebted countries. In Italy, the debt ratio is foreseen to be half a percentage point higher in 2006 compared to 2004, while Greece should succeed in reducing the ratio by 1.5 percentage points over the same period. Cyprus and Belgium are projected to bring down their debt levels by at least 4 percentage points of GDP, while Austria is set to record a more modest fall. At the other end of the spectrum, the Portuguese debt ratio is foreseen to rise by more than 6 percentage points of GDP, with less significant increases in France, Germany and Malta. 6

19 Overview Upside and downside risks to the forecast Although moderating, the momentum of global growth remains strong and trade growth is still vigorous. In addition, there is evidence in some Members States that domestic demand has started to recover, thus reducing the susceptibility of growth dynamics to the anticipated reduction of the external stimulus. Nevertheless, the outlook is not without its risks. On the external side, the recent surge in oil prices has once again put the spotlight on the potential dampening effects of higher and more volatile oil prices on global growth and trade. The risk of abrupt exchange rate adjustments remains in place in view of the ongoing global imbalances. More specifically, the US current account deficit remains large and it is financed mainly through the accumulation of official holdings of dollar-denominated assets in Asia. Although financial market developments to date may be interpreted as being consistent with a benign outlook for the world economy, there is still some cause for concern over the sustainability of this outlook. In this context, the possible risks include a more aggressive tightening of interest rates should inflation pressures intensify in some countries, a sharp correction of asset prices and the repricing of credit risk as investors become increasingly sensitive to risk exposure. On the domestic side, in view of the projected reliance of the growth forecast on domestic demand, a slower return of consumer confidence poses the main downside risk. Survey indicators suggest that consumers in some Member States are still hesitant about committing themselves to purchases of larger consumer durable goods. Should the continued rise in oil prices become more visible in domestic inflation, this would also lead to an adverse effect on consumer confidence. Furthermore, it may take longer for structural reforms implemented in several Member States to feed through to confidence. Finally, the deteriorating competitive positions of some Member States may also pose a downside risk, especially in those countries that rely on external demand as an important source of growth. The above downside risks are, to some extent, offset by a few upside risks. In view of the fact that the pace of investment has to date been lower than might be expected from favourable financing conditions and positive developments in earnings and profitability, stronger growth in investment cannot be excluded. The effect of the prolonged rise in house prices in a number of EU countries on household wealth could underpin a stronger acceleration in consumer spending in these countries. The labour market reforms undertaken by Member States represent an upside risk for consumer confidence and accordingly for the release of pent-up consumer demand, which could be financed through a reduction in the savings rate. Such reforms include the recent changes in Germany, as well as the past reforms in other Member States, which have led to greater labour market resilience and a decline in the non-accelerating-inflation rate of unemployment (NAIRU). In addition, the working-day adjustment, already mentioned above, may underestimate the strength of the underlying 7

20 Economic Forecasts, Spring 2005 dynamics in the fourth quarter of last year, thereby leading to a strongerthan-expected carryover of momentum into this year. Overall, however, the balance of risks is tilted towards the downside. The Candidate Countries Candidate countries are expected to continue to enjoy relatively strong growth over the forecast horizon. In Romania and Turkey, the pace of economic activity is projected to decelerate slightly in 2005 and 2006, after a particularly strong performance in Growth is set to accelerate in Croatia, whereas output expansion in Bulgaria is likely to peak this year, reflecting election-related public spending. Rising labour productivity and an expanding and modernised capital stock are the main sources of this continued expansion. Private consumption and, in particular, investment are also important driving forces behind the projected sustained growth over the next two years. Overall, inflation is forecast to decline in candidate countries. Turkey and Romania, in particular, are set to take a further important step towards price stability, as their inflation rates are expected to fall to around 6½% in The main factors behind this outlook are a strengthening supply side of these economies, driven by high investment, and overall prudent fiscal and monetary policies, combined with some real appreciation of the currencies of some countries. Only in Croatia are rises in administered prices projected to lead to a slight acceleration of inflation. It is envisaged that labour markets will benefit from strong output growth, which - despite sustained gains in labour productivity should lead to employment gains and falling unemployment. In Romania, the ongoing restructuring in industry and agriculture is expected to more than offset job creation in other sectors, leading to minor declines in employment and increasing unemployment. In Romania and, more particularly, in Bulgaria, general government deficits are set to remain quite moderate. This is supported by a projection of strongly rising revenues against a backdrop of strong economic growth. Existing higher deficits in Croatia and especially in Turkey are expected to narrow further. In all candidate countries, current account balances are forecast to remain fairly high, driven by strong domestic demand and higher world commodity prices. Rising trade deficits will only be partly offset by growing surpluses in other parts of the current account balance. 8

21 Chapter 1 The world economy

22

23 1. Global growth and trade to remain robust The global recovery is expected to continue, but at a somewhat slower pace. After growing briskly by about 5% last year, the fastest pace in decades, the world economy is set to expand by just over 4% in both 2005 and The deceleration in activity is expected to be accompanied by a somewhat slower expansion of global trade. The large global current account imbalances are projected to continue, while stabilising towards the end of the forecast period. High oil prices, driven by the strong growth in demand and the low level of spare oil production capacity, are likely to have contributed to slower global growth. Financial conditions, with low interest rates and low risk premia on corporate and emerging market debt, remain supportive for growth. While global economic activity is expected to stay robust, important downside risks exist, in particular the risk of disorderly adjustment of the large global current account imbalances. Furthermore, high oil prices remain a source of risk, in view of strong growth in oil demand and continued geopolitical risks. World growth remains robust after peaking in early 2004 Growth in the global economy peaked in the first half of 2004, with particularly high rates recorded in the first quarter in China, Japan and the United States. Subsequently, the pace of growth slowed to more normal levels in the United States, whereas Japan experienced slight decreases in real GDP in the second and third quarters of 2004, according to revised national accounts data. Graph 1.1: The global cycle 5 qoq % ch trade growth OECD retail sales -1 OECD industrial production OECD leading indicator Source: OECD, CPB Netherlands In China, after very robust growth in 2003 and in the first quarter of 2004, GDP growth decelerated considerably in the second quarter of last year, but picked up again in the last two quarters of the year. The moderation of the global expansion during the course of 2004 was reflected in the easing of world trade growth. After having grown at a very brisk pace between mid-2003 and mid-2004, the growth of trade decelerated in the third and fourth quarters. Growth in industrial production in the industrialised economies paused in the second half of last year, whereas consumer demand held up more strongly. This is evidenced by growth in retail sales for the OECD as a whole, due to strong US consumer demand. Despite the easing of the global expansion, which was to be expected following the above-trend pace experienced in the second half of 2003 and beginning of last year, world growth should continue to be robust over the forecast horizon. The rate of change of the OECD leading indicator picked up slightly in the final quarter of 2004 and this trend was maintained in January. Furthermore, purchasing manager indices are also continuing to indicate a solid rate of expansion at the start of this year. Graph 1.2: Growth projections for major economies and selected regions 9 yoy % ch USA Japan CIS Latin America Asia Looking ahead, the balance of world growth is expected to be relatively unchanged, with non-japan Asia continuing to exhibit very dynamic growth rates and the CIS countries also growing strongly. Among industrialised countries, the US economy - although more bouyant than expected in the autumn forecast - is projected to slow somewhat over the course of this year as growth in private consumption moderates. In 11

24 Economic Forecasts, Spring 2005 Japan, the recovery is expected to regain traction again, stimulated by world demand and by domestic investment growth, due to high capacity utilisation and an improvement in corporate profitability. Oil prices likely to remain high Oil prices have continued to be very volatile. After a brief respite from the upward trend towards the end of 2004, oil prices have already overtaken last year s record highs in USD terms. The price of Brent oil was trading at around 55 USD/bl. in the middle of March. Compared to the beginning of last year, oil prices have risen by about 70% in USD and somewhat less in EUR (about 60%). Graph 1.3 : O il price (Brent crude, $ and per bl.) USD EUR Source: Datastream The renewed surge in prices is caused by the fact that the oil market remains very tight as a result of high demand growth and low spare production capacity. According to the latest figures from the International Energy Agency (IEA), total world oil demand is estimated to have increased by 2.7 million barrels per day (mb/d) in 2004 (3.4%), a historically very rapid expansion. This has pushed oil production close to full capacity, which has made the price of oil more vulnerable to concerns about supply and demand imbalances. The International Energy Agency recently raised its demand forecast for this year, estimating that global demand will increase by 1.8 mb/d. This is significantly lower than the rise in 2004, but still a sign that oil demand remains strong. Demand in the importing regions of Europe, North America and China was stronger than expected in the fourth quarter of last year. Market participants expect a tight oil market, with futures prices indicating a medium-term price of around USD 45 per barrel. In view of these factors, oil prices are likely to remain high over the forecast period. The price of Brent is assumed to average USD 50.9 per barrel this year, which is 34.4% higher than the 2004 average. Next year, prices are expected to fall back slightly to USD 48 per barrel, a decline of 6% compared to This corresponds to a quarterly profile of gradually falling prices from the third quarter of this year onwards. Given the tightness of the oil market, there is a risk that prices could increase even further. Ongoing concerns about the security of supply and political uncertainties in a number of oil-producing countries continue to underpin oil prices, while demand growth has repeatedly proved stronger than expected. Financial conditions still supportive to growth Despite the apparent soft patch in growth in many countries in the second quarter of 2004, and the continued increases in oil prices, financial market developments have been characterised by stability. Graph 1.4: Interest rates (one-week moving average) % Euro area 15/03/ US 15/03/2005 Euro area 18/10/2004 US 18/10/ month 1 year 2 year 5 year 7 year 10 year Source: Datastream In the US, the Federal Reserve started to raise shortterm interest rates in the summer of 2004, in view of the maturing recovery and some concern about the future path of inflation. Nevertheless, the monetary policy stance is still accommodative and the gradual removal of monetary stimulus is expected to continue in

25 Chapter 1 The world economy While short term rates have increased in the US, long term yields stayed surprisingly low into early Inflation has increased somewhat but remains relatively low, and foreign investors continue to finance the US current account deficit, implying overall low pressure on long yields. For the euro area, the yield curve is virtually unchanged compared to the autumn forecast, with slightly lower long-term interest rates. Despite somewhat lower inflation, real interest rates remain accommodative to growth. Furthermore, financing conditions facing firms have continued to improve with corporate bond spreads remaining very low (see also section 2.2). Low risk premia are also benefiting emerging market economies. However, a disorderly adjustment of international imbalances could expose investors to sharp exchange rate movements and sharper-thanexpected interest rate increases. Housing markets, which have underpinned consumer demand in a number of countries, may also pose a risk in this respect. Graph 1.5: Major stock market indices (one-month moving average) Index 100 = 01/01/ Eurostoxx Dow Jones Ind Avg Nikkei Source: Datastream Despite high and volatile oil prices and uncertainties concerning the strength of the world economy, major equity market indices have been characterised by relative stability, with major stock market indices roughly unchanged or having gained slightly in the last year, on the basis of strong profit growth. After a period of general stability in the middle of last year, currency markets were again characterised by greater variability towards the end of last year. From mid-october onwards, the dollar depreciated against major currencies, with the euro reaching a record high of over 1.36 USD in late December Overall, the trend remains one of dollar weakness against the background of a large US current account deficit. The Japanese yen also depreciated in recent months, reflecting the weaker Japanese economic situation. Graph 1.6: Exchange rate developments JPY/EUR (rhs) Source: Datastream Risks remain on the downside USD/EUR (lhs) Despite the positive outlook for growth in the world economy, some risks are nevertheless apparent. The moderation of world economic growth in the second half of 2004 could prove to be more pronounced than expected, particularly in view of rising oil prices. Imbalances in the US economy remain the most important source of risk for the global economy. The current account deficit is expected to remain very large. A more abrupt adjustment of these imbalances would imply significantly lower growth in the US economy and would have consequences for the world economy through financial markets as well as lower trade growth and lower consumer and business confidence. Low risk premia on emerging market and corporate debt and housing prices in certain countries, could represent elements of particular vulnerability, should US long-term interest rates move up sharply. However, US growth has continued to surprise on the upside, and the projected slowdown in the second half of 2005 might be smaller than expected, due to resilient consumer spending and strong corporate investment, possibly helped by still-low long-term interest rates and strong corporate finances. 13

26 2. Outlook for major economies and selected regions The forecast for the US economy foresees annual GDP growth decelerating to 3.6% and 3.0% in 2005 and 2006, respectively. This represents an upward adjustment compared to the autumn forecast, but is still a slowdown from last year s above-potential growth rate of 4.4%. Growth in consumer spending, which has remained surprisingly strong, should start to decelerate as a result of a gradual rise in short and long-term interest rates and a weaker fiscal stimulus. Investment is expected to continue to rise, although at a somewhat slower pace than the 10% annual rate observed over the past year and a half. As a consequence of the lagged effect of the dollar depreciation in , the growth rates of exports are now projected to outstrip those of imports. This should lead to a stabilisation of the trade and current account deficits as a share of GDP in GDP growth in Japan has been revised downward considerably compared to the autumn forecast, mainly due to revised national accounts data. It now appears that the Japanese economy went through a technical recession in the second and third quarters of 2004, with a slight rebound in the fourth quarter. Despite this weakness, annual growth reached 2.7% in 2004, because of the strong first quarter performance and the carryover from the healthy growth in the second half of Looking ahead, most indicators point to a rebound in the first quarter of this year. On the back of continued, albeit less vigorous, global growth, sustained investment growth and a slight rebound in private consumption, GDP growth is expected to reach 1.1% and 1.7% in 2005 and 2006, respectively. Given the very slow deceleration in underlying deflation and the lower growth projections, the yearon-year change in the consumer price index may turn positive only towards the end of this year. Growth in the rest of Asia also gathered momentum in 2004, reaching 7.8% on the back of a strong global recovery and strengthening domestic demand. Largely due to an expected cooling of export demand, notably in the IT sector, the region is forecast to experience a deceleration in GDP growth to around 7.1% in 2005 and The macroeconomic impact of the tsunami on the Asia region is expected to be limited and relatively short-lived. Within the rest of Asia, after growing by 9.5% in 2004, the Chinese economy is expected to enter a phase of more sustainable growth. Following very robust growth in 2003 and in the first quarter of 2004, and the concerns about overinvestment and overheating in some sectors (such as steel, aluminium, cement, automobiles and real estate), GDP growth decelerated markedly in the second quarter of last year. This was partly the result of administrative measures, in particular restrictions on land use and credit rationing, gradually introduced by the authorities since mid-2003 to rein in investment in the overheating sectors. However, economic activity picked up pace again in the third and fourth quarters of the year, implying a modest acceleration in GDP growth for 2004 as a whole (to 9.5%, from 9.3% in 2003). The source of GDP growth has partially shifted away from investment towards net exports and consumption. A mild slowdown of economic growth is expected in 2005 and 2006, with growth projected to reach about 8.6% this year and 8.4% next year. In the EFTA-countries, growth has also been fairly strong. In Norway, economic activity continued to expand briskly last year, led by a further surge in private consumption. Real GDP growth is estimated to have reached 3% in 2004 and is expected to accelerate to 3.8% in 2005, before falling back to 2.9% in The recovery of the Swiss economy, which began in the second half of 2003, continued in 2004, with GDP growth of 1.7%. Expansionary monetary and fiscal policies have underpinned domestic demand growth. GDP growth is forecast to reach 1.3% and 1.7%, respectively, in 2005 and The four Candidate Countries are expected to benefit from strong domestic demand, driven by robust consumer confidence, declining inflation and strong, largely FDI-financed, investment growth. However, in spite of this, GDP growth is expected to slow down over the forecast period, to around 5% for the group as a whole. The decline in inflationary pressures is in general expected to continue, especially in the two high-inflation countries, Turkey and Romania. With the exception of Romania, the situation of public finances is expected to improve further, with Bulgaria being close to balance, while the deficits in Croatia and Turkey are expected to diminish towards 3% of GDP. The demand-driven growth is accompanied by significant current account deficits, which with the exception of Turkey have so far largely been financed by FDI inflows. 14